Aon Study Reveals Investors More Intolerant of Catastrophe Risk

March 14, 2006

Aon Re Global announced today that it has produced research on the impact of earnings volatility on shareholder value for insurers and reinsurers.

Hurricane Katrina and the entire hurricane season provided an interesting opportunity to observe, at an event and season level, the investor response to the related earnings and capital volatility, according to the Aon study.

“Katrina is the first significant natural catastrophe since Northridge and Andrew to truly test the risk and capital management plans of insurers and reinsurers. The relative intolerance of catastrophe risk from shareholders as seen through these events is instructive. Shareholders represent a tighter constraint on capital and earnings than rating agencies, says Mike Bungert, chief executive officer of Aon Re Inc.

Most of the industry discussion post-Hurricane Katrina has focused on the significant rating agency model changes and the compounding effect of catastrophe model changes. The Aon Re Global study tells the investor side of the story and represents an important addition to the information needed to optimize catastrophe retentions, limits and the use of the varying forms of underwriting capital, Aon officials said.

Aon Re’s dominant Prime Re DFA tool incorporates investor, rating agency and other constraints as it solves for optimal combinations of underwriting capital. Underwriting capital consists of equity, policyholders’ surplus, hybrid instruments, reinsurance, ART products, insurance linked securities and contingent capital.

Stephen Mildenhall, Aon Re Services EVP and author of the regression and study, summarized two of the key results, “Investors clearly understand the differences between insurers and reinsurers and have set differing tolerances for each. Our study confirms that investors expect higher earnings and capital volatility from reinsurers than they expect from insurers.

Key points in the regression showed that insurers were allowed capital volatility of 3 percent to 6 percent and were allowed to lose slightly more than a quarter of pre-Katrina consensus earnings before significant shareholder value deterioration occurred. Reinsurers on the other hand were allowed capital volatility of 12 to 19 percent and were allowed to lose an entire year of pre-Katrina consensus earnings before significant shareholder value deterioration occurred.”

The study reveals many more interesting facts surrounding the 2005 hurricane season and investor tolerances.

Aon Corporation is a leading provider of risk management services, insurance and reinsurance brokerage, human capital and management consulting, and specialty insurance underwriting.

Source: Aon Corp.

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